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Economics 311 Noelwah R.

Fall 2004 Final Examination: AK

Part I: Short Answer/True, False, or Uncertain questions. Please be sure to explain

your answers thoroughly. (30 points total)

1. A study reports a correlation coefficient of 0.45 between savings (measured in

dollars) and education (measured by years of schooling). Interpret this result. (5

The correlation coefficient tells us the degree of a linear relationship between variables. It is
related to R2 (goodness of fit measurement). The sign of the correlation coefficient tells us the
sign of the slope of the line. The closer the correlation coefficient is to +1 or –1 the stronger the
linear relationship between the two variables. The unit of measurement does not matter.

2. TFU: “In regressions where multicollinearity exists it may be impossible to

determine the statistical significance of one or more regression coefficients.”
Explain. (5 points)

Multicollinearity occurs when there is linear dependence among the regressors. This may result
from a high correlation (simple bivariate), but may also be a result of a more complicated
relationship between regressors.

When multicollinearity occurs the estimated standard errors are large which may result in a
failure to reject the null hypothesis when the null hypothesis isn’t true. This increases the
probability of making a type II error.

3. A regression of average hourly wage (measured in $) and education (measured

in years) yields the following results. (5 points)

Averagewagei = 0.7437 + 0.6416Educationi

se = (0.8355) (.981 )

t = (.89 ) (0.6536) R2 = 0.89 n = 13

a. Interpret the coefficient on education. Is the estimated coefficient statistically


The coefficient on education indicates that an additional year of education is expected, on

average, to increase the average wage by $.64. The t-critical value is based on 11 degrees of
freedom which, for a significance level of .10 (two-tailed test), yields a t-critical value of 1.796.
Since t* < t-critical we are unable to reject the null hypothesis. The estimated coefficient is not
statistically significant.

b. Fill in the missing numbers.

c. Is the coefficient on education statistically different from 1? Include the five steps
outlined by Mirer for conducting a hypothesis test.

1. State hypothesis: Ho is that Education = 1; H1 is that education ≠ 1.

2. Level of significance is established by convention = 5%
3. Construct the decision rule: There are 11 degrees of freedom, The t-critical value for a two-tailed test
with alpha = .05 is 2.201. Reject Ho if t* > 2.201
4. Estimate t*: (.6416 – 1)/.981 = -0.365.
5. State and interpret. Since t* < t-critical we cannot reject the null hypothesis that the estimated
coefficient is equal to 1.

4.TFU: The variance of the t distribution will always exceed the variance of the standard
normal distribution. Explain. (5 points)

As degrees of freedom increase, the t-distribution approaches the normal distribution. This can
be seen by comparing Tables A.1, A.2, and A.3. The probability that Z > 1.96 is .025 (which
doubled equals .05). The t-critical value that correspond to df = infinite and a significance level
of .05 is 1.96. So, in general, the variance of the t-distribution (the spread) will exceed the
variance of the normal distribution unless the degrees of freedom are very large.

5. In class we’ve used a rule-of-thumb that if a t-statistic is greater than or equal to 2

the estimated coefficient is statistically significant. Explain the basis for this rule-
of-thumb and the conditions under which is it is appropriate. (5 points).

This rule-of-thumb is based on the relationship between the area under a distribution function
and the number of standard errors a t* value is from the hypothesized value. We know that
approximately 95% of a distribution is within +/- two standard deviations of the expected value.
With sufficient degrees of freedom the rule-of-thumb of t* = 2 approximates a 5% significance
level (see Table A.2, df > 50).

6. In a recent study the Census Bureau reported that individuals without high
school degrees earned, on average, $18,900 a year in the late 1990s. People with
high school degrees earned an average of $25,000, college degree holders earned
an average of $45,400 while professional degree holders earned an average of
$99,300. Converting these annual figures to lifetime earnings, the Census Bureau
calculated that college graduates earned between $1.2 million to $2.1 million
more than high school graduates while professionals earned $4.4 million more
than high school graduates. Newspapers responded to this report by concluding
that the country would be better off with more education, for example, a Seattle

Post-Intelligencer story about this report was titled, “New government data
support what your parents told you all along about staying in school: A good
education does pay off.” Using the tools and theories covered in this course
explain why you agree or disagree with this conclusion. (5 points)

This newspaper studies are inferring causality based on a simple correlation. While education
can improve productivity (and earnings), there are other factors that are correlated with
education such as your parents’ education level.

Part II: Problems and questions requiring a longer answer. (25 points)

7. Ray Fair reports the following regression results in his 2000 Update on the effect
of economic events on votes for President:

Table 2: Three Sets of Estimates of the Vote Equation

(t-statistics in parentheses)
Sample: 1916-2000 1916-1996 1916-1960

GROWTH .691 .698 .805

(6.72) (7.45) (7.94)

INFLATION -.775 -.720 -.477

(-2.71) (-2.77) (-1.34)

GOODNEWS .837 .905 .701

(3.12) (3.86) (2.90)

PERSON 3.25 3.99 5.21

(2.50) (3.25) (4.26)

DURATION -3.63 -3.33 -2.08

(-3.04) (-3.07) (-2.34)
PARTY -2.71 -2.84 -3.58
(-4.65) (-5.21) (-6.23)

WAR 3.85 4.65 3.88

(1.46) (1.96) (1.72)

INTERCEPT 49.61 48.40 47.36

(18.08) (19.10) (21.88)

SER 0.0237 0.0215 0.0147

R 0.923 0.941 0.987

No. obs. 22 21 12

where :

• GOODNEWS = number of quarters in the first 15 quarters of the administration in which the growth
rate of real per capita GDP is greater than 3.2 percent at an annual rate except for 1920, 1944, and
1948, where the values are zero.

Assume it is 2012 and that you are working as a White House analyst. Jed Bartlett, the
incumbent Democrat, is running for reelection. 1 His campaign team wants you to use Ray
Fair’s research to predict his vote share.

a. Which of the three reported regressions would you use in your analysis? Provide a detailed
explanation. (10 points)

Should reflect on Fair’s paper. The number of observations for the third regression are troubling
although it does have the highest R2 of all the models. Debate between best fit and best predictive ability
(presumably we’d want the model that was the best predictor under these circumstances). I’d probably
use the second regression because it excludes the 2000 election (where Nadar was a confounding factor).

b. Using the regression selected in part (a) to estimate Jed Bartlett’s vote share for the
following scenario: (10 points)
• The Democrats have been in power for 1 term
• The growth rate of real per capita GDP was 3 percent

1Jed Bartlett is the President on the TV program West Wing. He is a Democrat, has a PhD in economics
and received a Nobel Prize.

• Inflation was 1.2%
• There have been 3 quarters of good news

1916-2000: 53.80; 1916-1996: 53.50; 1916-1960: 52.94

c. What advice/cautions/qualifications would you give about your prediction? (5 points)

Ray Fair’s models were a bit unstable. He presented a range of predictions using different models. The
difficulties that he discussed in the Clinton/Bush/Perot election year also occurred in the
Gore/Bush/Nadar election year, so the treatment of Nadar is important. In his article he didn’t have a
problem with autocorrelation and I didn’t see evidence of this in class, but it is time-series data and
should be tested for autocorrelation.